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Northstar Realty Finance Corporation (NYSE:NRF)

Q4 2013 Earnings Conference Call

February 27, 2014 810:00 AM ET

Executives

Al Tylis - President

David Hamamoto - Chairman & CEO

Dan Gilbert - Chief Investment and Operating Officer

Debra Hess - CFO

Ron Lieberman - EVP and General Counsel and Secretary

Analyst

Steve DeLaney - JMP Securities

Stephen Laws - Deutsche Bank

Dan Altscher - FBR Capital Markets

Bose George - Keefe, Bruyette & Woods

Operator

Good day, ladies and gentlemen, and thank you for standing-by. Welcome to the NorthStar Realty Finance Corporation Fourth Quarter 2013 Conference Call. At this time, all participants are in a listen-only mode. Later, we’ll be conducting a question-and-answer session and instructions will be given at that time. (Operator Instructions) I’d now like to turn the conference over to our host, Mr. Al Tylis, President of NorthStar Realty Finance Corporation. Please go ahead.

Al Tylis

Thank you very much. Welcome to NorthStar's fourth quarter and year-end 2013 earnings conference call. Before the call begins, I’d like to remind everyone that certain statements made in the course of this call are not based on historical information and may constitute forward-looking statements. These statements are based on management's current expectations and beliefs, and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.

I refer you to the Company's filings made with the SEC for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The Company undertakes no duty to update any forward-looking statements that may be made in the course of this call.

Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with Generally Accepted Accounting Principles can be accessed through our filings with the SEC at www.sec.gov.

With that, I am now going to turn the call over to our Chairman and Chief Executive Officer, David Hamamoto. David?

David Hamamoto

Thanks, Al, and thanks everyone for joining us. In addition to Al, I’m joined today by Dan Gilbert, our CIO and COO; Debra Hess, our CFO; and Ron Lieberman, our EVP and General Counsel.

During the recent fourth quarter U.S. GDP grew at 3.2% however recent economic indicators have been mix suggesting the possibility of more tempered economic growth in the near-term. The Federal Reserve continues to slowly taper stimulus efforts due to increased economic growth in the second half of 2013 and as communicated that it remains committed to keeping short-term rates near zero until there are further improvements in employment.

Within commercial real estate as the economy continues to expand operating fundamentals are strengthening and liquidity continues to improve in the capital market. New issuance investment volume for non-agency CMBS increased to 80 billion for 2013, compared to 45 billion during 2012, and is currently projected to be approximately 100 billion for 2014.

2013 was an extraordinary year for NorthStar. Total stockholder returns exceeded 100% in 2013 and we tirelessly executed on our key business strategies, completing $4.8 billion of investments including investments on behalf of our non-traded REIT across various commercial real estate asset classes and throughout the real estate capital structure. This diverse allocation of capital emphasizes the strength and breadth of our scalable platform and reflects the expertise our Company possesses to enhance and build the same value.

While 2013 was certainly a great year, we believe that the best is yet to come and we enter 2014 with a dynamic and energized organization focused on a robust pipeline of diverse and compelling investment opportunity across a broad spectrum of commercial real estate assets. Over our 10 year history as a public company, we have achieved an 18% compounded annual total return for our shareholders, a significant premium of over both the S&P 500 and the RMZ, which both yielded approximately 8% over that period.

We remain singularly focused on creating value for our shareholders as evidenced by the recently announced planned spinoff of NorthStar Asset Management Group Inc. or NSAM. This planned spinoff unlocks the significant value in our asset management business and in our diverse and powerful commercial real estate platform. We believe NSAM will be extremely well positioned for dramatic growth as we capitalize on compelling and exciting opportunities and continue to expand our business.

Looking ahead at opportunities for NorthStar and NSAM beyond many of the exciting investment opportunities that we see in the U.S., we believe international markets represent an opportunity to further diversify and prudently grow our asset base and asset management business. We’ve been exploring various investment opportunities and platform investments internationally and plan to have a presence in Europe soon.

Having built a strong international real estate presence while I was a partner at Goldman Sachs running its real estate principle investment business, I look forward to growing internationally and to sharing further details of our international expansion over the coming months.

Based on successfully executing our business plan, we recently announced our 10th consecutive quarterly increase to our common stock dividend to $0.25 per share, which was a 19% increase over the third quarter 2013 and 150% increase since we began increasing our dividend in November of 2011. This dividend represents the mid-80% payout ratio based on fourth quarter 2013 reported cap of $0.29 per share, compared to our mid-70% payout ratio in the third quarter.

The shift to a higher payout ratio reflects the strength and growth of our cash flow and our belief that the market was not appropriately valuing certain benefits with retaining a greater portion of our cash flow. Both the NRF Board and the NSAM Board will evaluate the respective dividend policies of each company following the closing of the spinoff.

Turning to our non-traded REITs, we’ve raised capital to-date of $1.4 billion with total 2013 volume increasing 55% over 2012. Our capital raising pace continues to pick up strong momentum with February sales expected to exceed January sales by over 40% despite less selling days in February, which means our average sales per day has also been increasing significantly.

Another strong sign for our sales momentum is that we have seen greater acceleration of capital raising in each subsequent vehicle as measured from beginning sales after breaking of escrow. We’ve also seen this positive trend in how we’re building our selling group of financial advisors as illustrated by NorthStar Income II already have itself in group that represents 97% of the sales generated from NorthStar Income I. Overall we’re very optimistic for continued sales acceleration throughout 2014.

In addition, we expect to launch a cosponsored multibillion dollar non-traded REIT with RXR Realty focused on commercial real estate in the New York Tri-State area. NSAM will manage this REIT and will initially be entitled to approximately 65% of the asset management fees from this non-traded REIT including NorthStar’s approximately 30% equity interest in RXR.

We’re excited about this launch as it will complement our current offering and feel confident that there will be strong market demand for this product and its sponsorship. We plan to be in a position to start selling this product later this year.

I’d like to turn the call over the Al, who’ll further discuss our business strategy and objectives. Al.

Al Tylis

Thanks, David. During the fourth quarter of 2013 we closed $799 million of investments, winning $480 million of invested equity. Our $3.6 billion of 2013 investments are projected to generate a weighted average current return on our $1.9 billion of equity invested of greater than 16%. Additionally during the fourth quarter on behalf of our sponsored non-traded REITs NorthStar made $330 million of investments.

Among our fourth quarter investments was the strategic $337 million debt and equity investment in RXR Realty. This strategic investment provides us with an attractive current return in addition to an ownership interest in trophy assets in New York City and a very high quality and growing asset management business. As we previously indicated our ownership interest in RXR’s asset management business will be effectively transferred to NSAM.

During the fourth quarter, we also acquired a $345 million manufactured housing portfolio and now own $1.5 billion of geographically diverse manufactured housing communities. We remain very bullish on the manufacturing housing space given its long-term strong and stable cash flows, high margins and low CapEx.

Earlier today we announced that we have entered into a term sheet on a $1.05 billion healthcare real estate investment. This potential acquisition demonstrates a very strong beginning to our recently announced partnership with Jay Flaherty. This portfolio is diverse covering 14 states with the largest concentration 35% in Florida, with strong lease coverage and a balance between assisted living and skilled nursing facilities.

In addition, a portion of the lower acuity assisted living properties which are more akin to traditional multifamily properties would be owned through a radius structure, which means that NRF would benefit from any growth of property level operating cash flows which provides for more upsides than a triple net lease structure. If we complete this acquisition we would own over $1.6 billion of healthcare real estate assets and look forward to continuing to work with Jay and create a preeminent healthcare real estate business.

We believe there is tremendous value in the over $4 billion of real estate that we would own, which excludes the substantial value in our indirect interest in real estate through our real estate private equity investments and our investment in RXR. And we trust that the public markets would appropriately value our real estate portfolios once NRF and NSAM split.

We believe that our real estate businesses fit well within NRF’s diversified commercial real estate portfolio, but would allow one or more of these to be standalone businesses at the right time if appropriate value was not ascribed to them within NRF. During the fourth quarter we also closed on our third real estate private equity transaction investing $40 million and we continue to see very interesting opportunities in this space.

We also remain active on the loan origination front completing $1.2 billion of loan originations for us our non-traded REITs during 2013. As we have discussed in the past NorthStar continues to expect long-term compelling opportunities originating floating rate loans due to the overall magnitude of commercial real estate loans coming due in the next several years and a continued improvement in the securitization markets. We have an experienced and proven origination platform with a strong reputation that has been tested through incredibly difficult markets and we expect our origination platform to prosper as the overall lending opportunity continues to grow in the coming years.

We have directly originated approximately 90% of the loans that we’ve closed since 2011, which demonstrates the depth and non-commoditized nature of our loan origination platform. Overall, we continue to realize significant progress of building a more diversified and less cyclical business. Between our compelling and differentiated investment pipeline and the potential to unlock value in our various businesses, we’re enthusiastic about the long-term value that NorthStar is creating for shareholders.

I’d like to now turn the call over to Debra, who’ll review our financial results for the fourth quarter and full year 2013. Debra?

Debra Hess

Thanks, Al and good morning everyone. As we saw in this morning’s press release we had strong results for the fourth quarter and full year 2013. Reported CAD for the fourth quarter 2013 totaled 74 million or $0.29 per share, compared to $65 million or $0.28 per share in the prior quarter. For the year CAD totaled $234 million or $1.06 per share. As we discussed on prior presentations we believe CAD is a very good indicator of our operating performance and is an important factor when evaluating our dividend.

During the fourth quarter, we deconsolidated our final CDO backed by loans to cap for CDO. As part of this deconsolidation we removed approximately $400 million of assets and liabilities from our consolidated balance sheet and recorded the CDO bonds that we own in our CDOs and this CDO equity at fair value. We reported a non-cash loss from deconsolidation of 46 million which was primarily attributable to the reversal of prior unrealized gains when we elected the fair value option and marked the liabilities to market.

Only four CDOs that are backed predominantly by CMBS remained consolidated in our balance sheet and we are actively engaged in seeking opportunities to deconsolidate these CDOs as well. As we have in the past discussed, the continued deconsolidation of CDOs is positive in so many ways, most importantly in improving transparency and reducing the complexity of our business and financial statements. Continue to wind down our legacy portfolio and for 2014 we expect that less than 10% of our cash flows will come from CDO equity distribution.

Looking at our portfolio post-spin and including a new potential of $1.05 billion healthcare transaction our total assets excluding assets underlying our CDOs will be fiscally $7 billion. 73% will be in real estate with 59% through direct interest and 14% through indirect interest in private equity funds and our interest in RXR. Our real estate portfolio is diverse across the property types and includes manufactured housing, health care, office and multifamily.

Earlier this morning we announced that we intend to launch an exchange offer for 7.5% exchangeable senior note and we intend to offer holders of these notes the opportunity to exchange with the newly issued 3% senior notes that mature on September 30, 2014. Subject to the terms of the exchange offer, holders that elect to exchange their 7.5% exchangeable senior notes will receive these new 3% senior notes and a principle amount equal to the value of parity of the existing 7.5% exchangeable notes plus two points.

Please note that the new 3% senior notes will not reference and may not be repaid in terms of common stock events then. At the maturity of the new 3% senior notes, which is expected to be following the spinoff of NSAM, NRF will have the option to settle them in either cash or common stock of NRF. In terms of the spinoff, we filed a Form 10 on February 5th and will remain on-track to complete the spinoff in the second quarter of 2014.

So with that, I’d like to turn the call back over to the operator for questions, operator?

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time we’ll begin our question-and-answer session. (Operator Instructions) And our first question comes from the line of Steve DeLaney with JMP Securities. Please go ahead.

Steve DeLaney - JMP Securities

Congratulations on another eventful quarter. Debra, I appreciate the information in the press release, the update on the convert activity. That was a question that we were thinking about with respect to the spin, so if we could chat a little bit about that it would be helpful. So, we calculated about 76 million shares, if we exclude the 7 in the quarters of 2027, we looked at the other three issues and we’re coming off about 75, 76, it was about 25% potential additional shares.

And in our view this is a non-issue for NRF because this is convertible debt and shares that are related to NRF’s balance sheet. But am I thinking right that when we think about potential CAD per share for NSAM. I remember to use that acronym rather than the NAM we had been using. It would seem that in modeling and trying to evaluate NSAM we need to weigh those incremental shares. So, I guess the question is this, you’ve reported I think 27 million related just to the 8 and 78s and the 5 and 38s which would be about a third of that 76 million.

Can you comment on I guess two things, what are you really trying to achieve here with the exchange offer on the 7.5s? And what is kind of the expectation that you’ll would have internally about the maximum amount of conversion of all three of these issues in terms of how it might impact the initial pro forma shares for NSAM? Thanks.

Al Tylis

Hey Steve, it’s Al.

Steve DeLaney - JMP Securities

Yes.

Al Tylis

So, okay so Steve we’ll have to be a little mindful that there is specific rules around exchange and tender offers that we can’t comment on what’s beyond the existing disclosure. But in terms of the math that you were doing, the shares that have exchanged to-date as you pointed out are shares today. And then if the exchange offer that we launched today were successful, there would be fully successful, you would have approximately 30 million less shares in NSAM.

Steve DeLaney - JMP Securities

Right, yes.

Al Tylis

And then with regard to the 5 and 38s what’s left on those our expectation is, if they convert before the spinoff, it would likely be a event in June, given that early exchanges don’t get accrued interest on their bonds. And we would expect to evaluate those as we get a little bit closer to the timing of the spinoff and that date.

Steve DeLaney - JMP Securities

Alright, that’s helpful and I certainly understand you are limited to what you can say, especially about the 7.5. And so, is this a correct assumption that assuming some holder of these converts just decides to do nothing and they are holding a convert past the ex-date, the record date for the spin. Is my assumption correct that at that point they may get adjustment to their conversion price but they do not get access to any NSAM shares?

Al Tylis

Right.

Steve DeLaney - JMP Securities

Okay, thanks. And just one follow-up that’s not related to that, the 1.1 billion healthcare deal, you guys do a great job of giving us sort of indicated ROEs on your various activity. Can you make any comment about have you modeled that internally and can you comment on what your expected return might be there given that’s such a large transaction?

Al Tylis

Yes, Steve and I think that would be a little premature at this time, but I would just make a general comment that we continue to deliver on the returns that we’re providing and focused on the 1.9 billion of equity that we’ve put to work last year in NRF and 16% current yield. I mean I think know we have a history of delivering, but I think with respect to this specific transaction we want it to be a little further along before we give the specifics.

Steve DeLaney - JMP Securities

Understood. Well, thank you David and I appreciate everybody’s comments.

Operator

Our next question comes from the line of Stephen Laws with Deutsche Bank. Please go ahead.

Stephen Laws - Deutsche Bank

Hi, good morning. Congratulations on a nice quarter, a lot of things going on. A couple of questions, you talked about the healthcare term sheet with increased resources there with Jay coming on board. How should we think about the growth opportunities there, how much larger of a focus will that be going forward. And I guess kind of as you look at how your pipeline has changed in the last four to six weeks, how much more active is that pipeline on the healthcare front?

David Hamamoto

I would make I guess a broader comment about our strategy and not just Jay, but also what we did with RXR. And I think that the business model that we have now is to pick leading sponsors in various niche sectors of the business to be our partner. And so Jay is a classic example of someone with a long expertise and relationships in the healthcare sector that not only knows the investing side, but has an incredible track-record in the public market. And I think you can say the same thing for Scott Rechler with his history with Reckson and what he does in the New York Tri-State area.

And I would say that the expectations that we had for both of these partnerships was high, but they’re already exceeding our expectations in terms of deal flow and how the partnerships are working. And I think both of these individuals have extremely strong relationships and understanding of the market that positions us really well to do negotiated off market transactions with various people in their spaces and not just make compelling investment opportunities, but also offers the opportunity to create new pools of capital which will be very important to continue growth and diversification of NSAM.

Stephen Laws - Deutsche Bank

Great. And moving to RXR which you mentioned in your comments there, I think that’s a $10 million fee initially as a minimum fee, have you guys muddled out as far as targeted growth, when you expect to hit an inflection point where we see fees on that management fee increase above the $10 million mark?

David Hamamoto

Yes, I don’t think we have anything specific at this point, but I would just echo my earlier comments that so far the results in terms of the deal flow and the growth in those businesses are exceeding our underwriting.

Stephen Laws - Deutsche Bank

Great. And to the non-listed REIT product that you announced for the launch, how does that impair or contrast another Tri-State focus for the RXR, but with the theory that two fund that’s currently raising capital are those competitive funds complementary, will there be co-investments, kind of how do you view the growth opportunities of each of those respectively?

David Hamamoto

Yes, we think that they’re not competitive, they’re focused on different investment strategies and I think as we’ve said before, we believe that our broker dealer distribution system can handle up to four different products, that’s probably the, makes the sales organization most efficient. So, we as the RXR non-traded REIT gets added to the platform, we think that’s incremental sales once it’s up and running which as we said is probably going to happen sometime later this year. But the investment strategy will not be competitive.

Stephen Laws - Deutsche Bank

Great. And then one final question I’ll follow up later, but some comments out of some other players about the conduit loan market, increased competition pressuring margins there. Do you guys have any kind of broader comments, and I know your platform is diversified significantly in the last couple of years and have lot of capital allocation opportunities to target mid-teen ROEs, but can you maybe comment on what you’re seeing in a broader market on the conduit loan business?

David Hamamoto

Yes, obviously I commented on CMBS volume increasing and that market is getting more and more liquid. It’s not a sector that we’ve been particularly focused on, and particularly at this point in the cycle as margins continue to shrink. So, I think we continue to focus on sort of the higher margin businesses, the direct equity investing or some sort of hybrid, but when we do loans we look for the higher spread loans where we’re not competing against the conduit market.

I think a conduit market has provided a great source of financing our equity real estate where when it is overbought and getting more frosty we love being the equity owner that borrows from that market. So, we would see the strength in that market being a big driver for the returns that we can generate on the equity side of the business.

Stephen Laws - Deutsche Bank

Great. Thanks for the comments. I appreciate you taking my questions.

Operator

(Operator Instructions) And our next question comes from the line of Dan Altscher with FBR. Please go ahead.

Dan Altscher - FBR Capital Markets

Hey, thanks. Good morning and thanks for taking the call. Probably have more listeners on the call today than ever have before. So, I think that’s a good thing. Procedurally I was just wondering if you can help us understand what needs to happen between now and the spin, if it’s just the matter of given some documentation and paperwork or really what needs to happen and timing wise are we looking more of early second quarter or late second quarter?

David Hamamoto

Hey Dan, yes I think clearly interest has picked up and we do have I think a record number of participants on the call today. In terms of the spinoff, I mean you saw we submitted the Form 10 to the SEC, so now we’re just waiting to get comments. Once we get comments, we need to include some additional information and then turn that back. So that’s the largest driver of the timing. It’s hard to predict how quickly they get back, the level of comments, and how many turns we need to go through. So, we feel good it’s a second quarter event, but in terms of more specifically it’s hard -- as we get hopefully a little closer and down to the final turn of the Form 10 with the SEC, then I think we can be more specific in terms of the timing. That’s the biggest gaining item.

Dan Altscher - FBR Capital Markets

Got you, okay. Thanks, that’s helpful. Going back to I guess the December 10th, sort of December 11th, slide deck. You kind of give a high level view of the two platforms, the REIT and then NSAM separately, and gave I guess some rough numbers of $0.80 a CAD and $0.30 a CAD. I understand it may not have been guidance, but just kind of a rough view of what made sense at the time. I feel a lot have changed between now and then. So I’m wondering how is your view of the world changed also from a CAD earnings perspective for these two respective entities going forward based up on, kind of like what we know now?

David Hamamoto

We’re going to be posting our simple quarterly slide deck following close of business Friday, and that will have some updated information in terms of cash flows and some expectations for 2014 for both entities following the spin-off.

Dan Altscher - FBR Capital Markets

Okay, that’s helpful. One final one on RXR, I appreciate the press release and comment that 11% yield on the invested equity. Can you maybe just help us understand the different parts there, how much of the 337 was debt, and how much was preferred, how much was equity and maybe kind of the respective yields on that?

David Hamamoto

Yes, you’ll see when we file our 10-K, it’s broken up. The preferred and debt was 250 million and the remainder was equity. There is a coupon on the debt and the preferred and then the residual is the equity yield. So the combined yield cash-on-cash going in is 11%.

Dan Altscher - FBR Capital Markets

Okay. And sorry, I just had one other quick one. For the exchange holders who have already, the convert holders who have exchanged, was that all equity share issued or was there also some cash settlement there as well?

David Hamamoto

It was share settle.

Dan Altscher - FBR Capital Markets

Okay, thanks so much.

David Hamamoto

Thanks, Dan.

Operator

Our next question comes from the line of Bose George with KBW. Please go ahead.

Bose George - Keefe, Bruyette & Woods

Hey, good morning. Actually on the healthcare portfolio acquisition, roughly how much cash do you think that will consume?

David Hamamoto

It sort of depends. We are in the market looking for the most efficient financing. So, I think it’s hard to say at this point, but my sense is we’ll finance somewhere between 60% and 75% of the purchase with that depending on the terms of the market.

Bose George - Keefe, Bruyette & Woods

Okay, great. And actually just going back to the commentary you’d given on the non-traded REIT sales, on the per day basis, just curious where that’s running now?

David Hamamoto

Yes, it’s been, it’s picked up in February as David mentioned it -- we’re up -- we expect February to be up over 40% over January. Last few days have been continuing to increase with around $3 million a day for the combined vehicle.

Bose George - Keefe, Bruyette & Woods

Okay, great. Thanks. And then the RXR non-traded REIT vehicle is that going to be both debt and equity?

David Hamamoto

Yes.

Bose George - Keefe, Bruyette & Woods

Okay, great. Thanks very much. That’s all I had, good quarter.

David Hamamoto

Thanks.

Operator

Ladies and gentlemen, this conference would be available for replay after 12 PM Eastern Standard Time, until March 6th at midnight. You may access the replay at anytime by dialing 1800-406-7325 or 303-590-3030 and your access number will be 4666318.

That does conclude our conference for today. Thank you for your participation. You may now disconnect.

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